Business strategies for thriving with high inflation

Inflation is expected to be running at well over 5%pa when consumer price data is released on 27 January by Statistics New Zealand. This rate of price increases is something we haven’t seen in decades, and contrary to what some are saying it is not just driven by temporary global supply-side factors.

Pricing pressures are occurring across all different types of goods and services. It’s not just things which rely on international supply chains where we have rising prices. Inflationary pressures are apparent for both tradeables (eg. imported goods) and non-tradeables (eg. a haircut).

I hope like heck that we get inflation under control in the first half of 2022, but increasingly I am becoming concerned that our inflationary pressures may take longer to stamp out. The fact that the Reserve Bank’s Survey of Expectations showed people expecting inflation in 2 years to still be running at 3%pa has done nothing to quell these concerns.

In the meantime, the reality is that inflation is real for the time being and will be a dominant theme for decision-making over the months ahead.

Inflation will hit different people in different ways. In an interview just before Christmas with Stuff’s Melanie Carroll I talked about which households will be hardest hit by inflation. The crux was that inflation hits poorer households the hardest as they have less capacity to absorb price increases or adjust the types of things they consume.

The same goes for businesses, with some businesses in a better position than others to navigate the unfamiliar environment of more rapidly changing prices for their supply chain and the goods that they sell. The rest of this article considers how businesses can respond.

How can inflation affect my business?

Not all businesses will have experienced the full burden of inflation yet. Inflation tends to flow through an economy in an uneven fashion and impacts each business differently.

For example, some businesses procure their supplies in an ad hoc fashion and have to accept any price changes as they occur, while others might be on fixed contracts which only renew every 12 months. But regardless of which way you procure your supplies, most businesses are going to see increased pressure on the prices they are paying their suppliers over the months ahead.

Even if your business is fortunate to not rely heavily on raw supplies or can substitute to materials that haven’t had as much pricing pressure, then there are still other ways which inflation may affect your input costs.

For example, you may find that your debt servicing costs increase as bank interest rates have already lifted 1.5% to 2.0% over the past six months. These increased costs for debt are occurring as markets anticipate higher inflation and the Reserve Bank has lifted its target interest rate.

You may also find that your workers have begun to demand steeper wage increases than in the past. Indeed, recent data from payroll statistics showed that average salaries rose 7.6% over the 12 months to November 2021 – a 20-year high.

How can my business respond to inflation?

In a higher inflationary environment, the stakes are raised for businesses when it comes to protecting your profit margins. The uncertain nature of inflation means that you need to adapt your planning processes to cover multiple scenarios. You also need to be agile in your procurement practices and in how you price your good or service. I strongly urge businesses to make inflation a top priority in your business planning for 2022.

The following four factors are things to think about when it comes to your strategy to thrive in a potentially higher inflationary environment:

  1. Use multiple inflation scenarios
  2. Control your supply chain risks
  3. Don’t forget labour market risks
  4. Become a price setter.

1. Use multiple inflation scenarios

The running joke last year was that economists have predicted 10 of the last three recessions. The message being that any forecasting by economists is a dark art and has error bands.

So rather than pinning your success to hoping you have chosen the ‘right’ set of economic forecasts, it is best to test your business using a range of inflationary scenarios.

These should be framed around what-if scenarios – for example, what if my raw material costs increase by 5% or 25%, what if I had to lift wages by 15%, or what if my interest expenses double?

Importantly you need to think about how much of an effect each scenario would have on your bottom line and how your business would respond – either in a preventative fashion now or in a reactive manner at the time. To assist in this thinking, you will need to consider the types of pricing metrics you will follow to ensure you know what is happening before it is too late.

2. Control your supply chain risks

Each business’s supply chain will look a little different, with some relatively straightforward, while others will be enormously complex. Some business owners will have put little thought into their supply chains over recent years, as relatively stable pricing and efficient logistic systems have meant that supply chains have had few apparent risks.

But in a higher inflationary environment supply chains can’t be taken for granted, and businesses would be wise to review risks in their supply chain. Any dependencies on a single supplier or on a single raw input, particularly those that are difficult to store or have long lead times for delivery are areas of concern.

To mitigate any supply chain risks, businesses may need to consider building latency into supply chains via alternate suppliers or substituting one raw input for another. Some businesses may find it cost effective to explore efficient storage options for stockpiling any critical supplies. For other businesses it may also be appropriate to renegotiate supplier contracts to give more certainty over long-term pricing or engage in hedging of their commodity price.

3. Don’t forget labour market risks

In higher inflationary environments there will be increased pressure on wages. These pressures will mount across most professions and skill levels. They will be particularly apparent for employees or contractors who can easily move between employers or industries, as these people can more nimbly chase higher wages.

Businesses would be wise to mitigate labour market risks using a multi-pronged approach. Firstly, businesses can’t hide from the fact that they will need to increase their pay offers for the years ahead. It’s best to be proactive on this front and show your staff that you value them.

Secondly, instilling loyalty among your workforce via developing a better workplace environment and providing non-cash benefits such as training and flexible work arrangements are also important. Labour market surveys show time and time again that employees value more than just money and that businesses with happier workforces have higher retention rates.

Finally, for some businesses it may be appropriate to explore investing in automation or other technologies which can improve the productivity of their existing workforce. Such solutions can help your business keep growing its output while being more efficient and less vulnerable to labour market shortages.

4. Become a price setter

The considerations to date have focussed on mitigating the cost side of inflation, but businesses can also protect profit margins by increasing the prices they charge customers.

Before increasing prices, businesses must strengthen their pricing power. Businesses must assess what sets them apart from their competition and how they can improve the uniqueness or allure of their good or service. Invest in telling your story, improving your customer experience, and offering better after care are important. The more you can differentiate your product and create loyalty to it then the greater your ability to lift your prices.

Unfortunately, you may also find that your current customer base has little ability to shoulder price increases, so it may be that you need to shift your marketing focus to people who are less price sensitive.

For other business, it may be appropriate to reassess the frequency with which you adjust pricing. You may want to shorten contract lengths or in some cases include mechanisms for passing on cost increases. Be careful though that what you pass on is fair and reasonable, and that you have carefully communicated with customers.

The main message is be prepared

The most important message in a higher inflationary environment is to be prepared. No one can be quite sure of the precise composition of inflation affecting your business in 2022, so make sure you have considered multiple scenarios and thought about what strategies you will put in place to mitigate any risks.

Your strategy might involve lifting prices, but it might equally involve a combination of better supply chain management or other ways of creating a more efficient business. Businesses that can protect their margins in a higher inflationary environment will be those that have a competitive edge over the competition.